REASONS TO DO A 1031 EXCHANGE
1. High Cash Flow / No Involvement | 2. Diversify Holdings | 3. Better Markets | 4. Delaware Statutory Trust
A 1031 Exchange is a greatly valued strategy that allows investors to exchange their property for a better one while deferring the tax payments. If you’re doing it for the first time, you probably have a lot of questions about how it will benefit you. We have worked with many investors who have sold their properties through a 1031 exchange for a number of reasons. This guide will showcase the most common reasons why an investor will sell their assets through a 1031 exchange and what they gained from it.
EXAMPLE #1 : HIGH CASH FLOW / NO INVOLVEMENT
A reason why someone would do a 1031 exchange is they want to trade into a property that has a solid cash flow with little involvement as possible. Take for example of 166 Michael Dr., the owner wanted a reliable source of passive income without being involved with the upkeep and maintenance. They exchanged the fourplex for an established Dollar General in Meridian, MS, and a soon-to-open Checkers located in Statesboro GA. Both of these properties are occupied by a single tenant that has signed a Triple Net Lease. This allowed the owner to have a reliable cash flow without having to be responsible for the property.
BEFORE 1031 EXCHANGE
Rents were at or below market rate
Significant management responsibility
State rent control restricted the ability to increase rents
Regulations delayed the eviction of problematic tenants
Unpredictable cash flows due to potential disruption
AFTER 1031 EXCHANGE
Dollar General is already well established in the area
Checkes is a new construction that will open in 2022
New corporate guaranteed lease
Zero management involvement and responsibilities
Consistent cash flow with minimal unexpected disruptions
EXAMPLE #2 : DIVERSIFY HOLDINGS
A reason someone would do a 1031 exchange is they want to diversify their investment holdings. For example; two multifamily properties that were exchanged for retail properties. Both of them were doing solid in regards to generating income but the owner had too many in their investment portfolio. The owner wanted to diversify their holdings in regards to the type of property and its geographical location. That is why they exchanged 5723 Via Monte Drive for a Walgreens in Madera, CA and 5719 Via Monte Drive was exchanged for a Burger King in Uintah, UT.
BEFORE 1031 EXCHANGE
Too many investment properties in one market.
An investment portfolio that isn’t diversified is very vulnerable.
Regulations and local rent control result in limited economic growth.
Properties had a low capitalization rate.
AFTER 1031 EXCHANGE
Investment properties are spread out in different markets.
Diversified portfolio isn’t so vulnerable to unexpected disruptions
Triple Net lease means zero management responsibilities
Consistent year after year cash flow.
EXAMPLE 3: BETTER MARKETS
Sometimes one could have a lucrative investment but it’s located in a difficult market. For example; 2037 Central Ave. is a nine-unit property located in the heart of Alameda, CA. In theory; owning a property on an island with limited development opportunities should be a lucrative investment. In practice; local rent control and regulations made any potential for a profit an uphill battle. That is why it was exchanged for two multifamily properties in more friendly markets. Instead of having a nine-unit property, they have a property that is 10 units and 8 units.
BEFORE 1031 EXCHANGE
A single nine-unit property.
Located in a market that is difficult for most investors.
Costly maintenance and seismic retrofit.
Local rent control and regulations resulted in unpredictable cash flow.
Opportunity to increase cash flow was very limited.
AFTER 1031 EXCHANGE
Two properties that are 10 units and 8 units.
Located in a growing market with so much potential.
Minimal maintenance is needed and no seismic retrofit.
Limited rent control and regulations that are friendly towards landlords.
Opportunity to increase cash flow by 50%.
EXAMPLE 4: DELAWARE STATUTORY TRUST
The 1031 exchange has a lot of benefits but other factors may not be favorable towards an investor. That is why some may opt to do a 1031 Delaware statutory trust. Take for example the owners of 142 Santa Lucia Ave., who wanted to do a 1031 exchange while also not wanting to be too involved in their future venture. They opted to establish a Delaware statutory trust, which will manage their holdings without the tax burden or the need to be involved and meeting the requirements for a 1031 exchange.
BEFORE 1031 DELAWARE STATUTORY TRUST
Six unit property that required a lot of involvement.
Significant management responsibility
State rent control restricted the ability to increase rents
Unpredictable cash flows due to potential disruption.
AFTER 1031 DELAWARE STATUTORY TRUST
DST is a separate legal entity.
Liability and asset protection for all involved.
Little to no management is required.
Don’t have to pay CA franchise taxes
Reach out to us if you don’t see the answer to your question or would like additional information about 1031 exchanges.